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EDITORIAL: Yesterday, S&P Global cut Pakistan’s long-term sovereign rating by one notch to “CCC+” from “B”. The rating agency’s decision is said to be based on country’s weakening of external, fiscal and economic metrics. Pakistan’s economy is going through a profound crisis. The grimness of this crisis has found its strong reflection in, among other things, the performance of the stock market. The price to earnings (PE) ratio is one such demonstration of this fact.

According to Bloomberg data, the trailing PE ratio at 4x is the lowest since 1998-99, versus the past 17-year average of 10.1x. This implies that investors are expecting earnings to fall significantly in nominal terms going forward. That is why perhaps it is hard to find any player in the market, whether broker or analyst, who is bullish or optimistic about 2023. And that in itself is a rarity, as brokerage houses usually exhibit a bullish bias.

A recently published market strategy report by stockbrokers, Topline Securities, suggests that the real return on the stock market investment would be negative, i.e., less than what an investor can gain from investing in the fixed income instruments and securities.

Earlier this week, the stock market had a free fall; there were hardly any buyers. The underlying structural issues have created a sovereign solvency risk and with the noisy political humdrum, investors are becoming increasingly worried.

That Pakistan’s stock market has not been able to perform well for many years is a fact. The PE discount to peers keeps on growing. One reason is higher weightage of oil and gas, and banking companies in the index.

The oil and gas stocks’ performance has remained lacklustre for over a decade now due to the ever-growing circular. Initially, it was only the power sector circular debt. Now the gas circular debt is hampering the ability of E&P companies to pay dividends, and the risk on their balance sheet is growing due to increasing receivables from gas distribution companies.

The problem in the banking sector is the too high an exposure on account of sovereign/government debt. The private sector credit as percentage of GDP shrank from 27 percent in 2007 to 16 percent in 2022, and the advance to deposit ratio of a number of banks is under 50 percent now. They have very high exposure of government treasury bills (T-bills) and Pakistan Investment Bonds (PIBs).

The growing government debt solvency risk is reflected on the banks’ balance sheets. It is important to note that Ghana, a West African country, is today faced with a major economic and financial crisis. Its decision to suspend all debt service payments under certain categories of its external debt, pending an orderly restructuring of the affected obligations, has made investors and creditors of banks in Pakistan uneasy.

Be that as it may, the health of most of the remaining companies in the index is deteriorating too. According to Topline’s calculations, the trailing PE of ex-government banks and circular debt is 4.5x. Such valuations were the case when economic sanctions were imposed after the nuclear tests in 1998-99. At that time, the country was in debt stress. So is the case today.

At that time Pakistan managed to avert default on its external debt through restructuring and this time, too, debt reprofiling seems imperative. The other countries where debt restructuring is happening – such as Sri Lanka and Ghana – the market PE is between 2x to 4x. Pakistan may not need debt restructuring for both domestic and foreign debt. What it needs is reprofiling of the external debt. The problem is not too much debt, but too much prepayments and too low reserves.

The debt repayment is around $25 billion each in this year and the next two. While State Bank of Pakistan’s (SBP’s) reserves were a little above $6 billion after a decline of $570 million (as of Dec 16). This constant headache of arranging debt to replace debt is the principal reason behind jitters.

Pakistan’s market debt is less than 10 percent and so is the commercial debt. The debt is primarily distributed between country’s friends and multilaterals. In the case of multilaterals, new debt can be contracted to repay the maturing obligations.

The reprofiling of friendly countries’ debt is imperative by converting short-term debt into long-term once. But for anything to happen, being in an IMF (International Monetary Fund) programme is imperative. However, to get the Fund’s nod, the currency would have to be adjusted and interest rates must increase along with an increase in energy prices and introduction of some new taxes. All this news is negative for the market. Higher interest rates would imply more conversion toward fixed income instruments.

Higher taxes are negative, as tax rates on many blue-chip companies are already too high. Thus, with or without the IMF’s involvement, PSX is likely to remain in stress throughout the year 2023.

Copyright Business Recorder, 2022


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